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WASHINGTON—Regulators proposed expansive new requirements for private investment funds Wednesday as part of a widening effort to police a rapidly growing but relatively opaque corner of the capital markets.

In a morning meeting, the Securities and Exchange Commission passed a proposal that would force hedge funds and private-equity funds to provide basic disclosures to their investors and guard against conflicts. The Democrat-controlled commission approved the proposal by a 3-to-1 vote. The agency will now seek public comments for at least two months before issuing a final rule.

Managers of private-equity and hedge funds have less oversight than their counterparts in the mutual-fund industry because they cater to wealthy clients and institutional investors. The SEC views these investors as more sophisticated—and capable of fending for themselves—than small investors.

Wednesday’s proposal would mark a sea change. For the first time, private-fund managers would be required to provide their investors with quarterly statements detailing fund performance, fees and expenses, as well as manager compensation. Funds would have to undergo annual audits, in an effort by the SEC to place a check on asset-valuation estimates often used to calculate fund managers’ fees.

SEC Chairman Gary Gensler said the proposal reflects the growing importance of private funds, which hold more than $18 trillion of gross assets. He noted that their investors include pension plans representing millions of Americans, as well as university endowments.

“Private fund advisers, through the funds they manage, touch so much of our economy,” Mr. Gensler said. “Thus, it’s worth asking whether we can promote more efficiency, competition, and transparency in this field.”

While the new disclosures proposed Wednesday wouldn’t have to be filed with the SEC or made public, private funds would be required to maintain books and records to allow regulators to assess their compliance with the rules.

Private funds would also be prohibited from certain practices that could motivate asset managers to put their interests ahead of their clients’ or be “contrary to the public interest,” the SEC said in a fact sheet.

The proposal is likely to garner resistance from financial firms such as Blackstone Inc. and KKR & Co. Inc., that have a powerful lobbying presence in Washington.

“We work closely with our investors to ensure they have the information they need to make the best investment decisions,” said Drew Maloney, president of the American Investment Council, a private-equity trade group. “We are concerned that these new regulations are unnecessary and will not strengthen pension returns or help companies innovate and compete in a global marketplace.”

The GOP also is poised to push back. Hester Peirce, the lone Republican among the four current SEC commissioners, said she wouldn’t support the proposal, which she characterized as a recasting of the agency’s mission to protect small investors.

“It embodies a belief that many large, sophisticated institutions and high-net-worth individuals are not competent or assertive enough to obtain and analyze the information they need to make good investment decisions or to structure appropriately their relationships with private funds,” Ms. Peirce said of the proposal. “Our resources are better spent on retail-investor protection.”

SEC examiners have highlighted a range of compliance deficiencies in private funds, saying in a report last month that managers sometimes give investors misleading information about their performance to charge higher fees.

Currently, hedge funds only have to file quarterly snapshots of their equity holdings to the SEC.

While the SEC hasn’t announced major actions against big crypto exchanges, the commission has threatened to sue companies offering crypto lending. WSJ’s Dion Rabouin explains why this one part of the crypto market has drawn such a strong reaction. Photo: Mark Lennihan/Associated Press

The quarterly statements added under Wednesday’s proposed rules would require liquid funds to provide net total returns since inception, over certain time periods and each quarter during the current calendar year. In the case of illiquid funds, the statements would provide the gross and net internal rates of return, as well as gross and net multiple of invested capital for the illiquid fund to capture performance from the fund’s inception through the end of the quarter.

Wednesday’s proposal follows another set of disclosures the agency proposed for private funds in January. That rule was geared toward enabling financial regulators to better spot risks building up in private markets.

The SEC also voted unanimously to issue a proposal that would shorten the time it takes to settle securities trades, a plan that gained momentum after the meme-stock frenzy of January 2021 exposed problems with the plumbing of the U.S. stock market. Settlement is the process in which securities are delivered to the buyer and cash is delivered to the seller.

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Under the proposal, Wall Street would switch to so-called T+1 settlement in which securities trades are settled one business day after a trade is agreed upon by March 2024. It currently takes two business days to settle trades.

Speeding up the settlement process could lower the amount of collateral that brokers must post at the National Securities Clearing Corp., the clearinghouse for U.S. stock trades. On Jan. 28, 2021, Robinhood Markets Inc. blocked its customers from buying shares of GameStop Corp. and other meme stocks after the brokerage received a $3 billion margin call from the NSCC. After that episode, Robinhood was among the firms that advocated for accelerating the settlement process.

The SEC’s proposal stops short of ordering T+0 settlement in which trades would settle the same day. Proponents say markets would become more efficient with same-day or even instantaneous settlement. But Wall Street lobbying groups have said same-day settlement would require a fundamental overhaul of many of the stock market’s processes and could introduce new risks.

Write to Paul Kiernan at [email protected] and Sebastian Pellejero at [email protected]

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Source: WSJ

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